Cause and Effect in European Politics and Law

If Bulgaria Wants to Catch up with the EU It Needs to Run

Ralitsa Kovacheva, July 6, 2012

Although slowed down by the crisis, the Bulgarian economy has gained some benefits from it as well - some external imbalances have been corrected, labour productivity has increased and wages have not stopped growing. The country’s challenge now is to keep the gains and build on in order to stimulate rapid growth - to reform its labour market, to increase productivity in a sustainable manner, to specialise in sectors with high added value.

These are some of the findings of an in-depth review by the Directorate General for Economic and Financial Affairs of the European Commission under the procedure for monitoring and correction of macroeconomic imbalances. The new procedure, an element of the enhanced economic governance, was launched in February with the European Commission's Alert Mechanism Report. Based on data, covering a three-year period (2008-2010), and on 10 indicators, taking into account external and internal imbalances, the Commission determined 12 countries to be analysed more thoroughly (Belgium, Bulgaria, Cyprus, Denmark, Finland, France, Italy, Hungary, Slovenia, Spain, Sweden, UK). For each of these countries an in-depth analysis is prepared, based on which the Commission will decide whether imbalances exist and what to recommend to the respective countries.

As in the recommendations to Bulgaria within the European semester, this analysis pays attention also to the labour market. Bulgaria has registered one of the sharpest declines in employment in the EU - by 9% in the period 2009-2011. As a result, the unemployment rate has doubled - from 6% to 12% in early 2012. Low-skilled workers are most seriously affected, while skills and geographical mismatches create prerequisites unemployment to become structural if no reforms are carried out. The strong decline in working-age population and emigration exert additional pressure on the labour market.

While the reduction of employment contributes for the higher productivity of the Bulgarian economy, the increase of unit labour costs (ULC) has consistently outpaced productivity. Statistically, rising ULC may also reflect the "whitening" of the economy, the analysis notes, but warns that this could become a problem when the economy starts growing again. Therefore, "labour market and wage setting institutions should therefore provide the necessary flexibility to keep wage growth in line with productivity growth,", which in no way means to keep them low, as often Bulgarian media interpret this.

The analysis addresses the issue in light of the fact that Bulgaria is a catching-up economy with the lowest wages in the EU (35% below Romanian average) and the lowest price level (50% below EU average). Although increased by 13% (year on year) in 2011, the total labour cost per hour remains the lowest in the EU - 3.5 euro, while in Romania it is 4.2 euro and an EU average of 23.1 euro. So it is clear that there should be catching up in terms of pay, but not at any price.

Wage growth is driven by the private sector because public sector wages have been frozen for three years (2010-2012), as well as pensions. The increase is due to reduced employment and increased productivity of those who had kept their jobs, so, as the analysis notes, there is "an artificial upward pressure on the productivity". The challenge is Bulgaria to be able to maintain these benefits when the economy starts growing.

Unlike other EU countries, wage growth in Bulgaria is influenced by market forces rather than collective bargaining (which covers only 14% of employees) and indexing (24%). The labour market and wage setting are regarded as being relatively flexible. But there are administrative reasons, which artificially inflate wages and moreover, could have adverse side-effects on the labour market. These are the sectoral and occupational minimum thresholds for social security, designed to combat the shadow economy and undeclared work. Particularly in sectors where minimum thresholds are set too close to the average wage for the sector, it may price out workers in some low-skilled segments and regions of the labour market, the analysis warns and recommends the thresholds to be reviewed.

Despite the increase in nominal ULC, however, Bulgaria's exports remain competitive. This is good news, but there is no cause for pride, because the reason is again the lowest level of wages in the EU - the average salary in 2011 was 350 euros. Bulgaria has shown strong gains in global export market shares, specialising in the export of raw materials (basic metals, minerals, petroleum products, wood, agriculture) and basic low-value added goods (clothing, tobacco products). In comparison with other EU countries, Bulgaria can boast strongly rising export prices - 9% in 2010 and 10% in 2011. However, export prices are highly dependent on global commodity prices which means higher macroeconomic vulnerability. That is why it is important to ensure conditions in the labour market that will allow a flexible wage setting, but the observations of the experts show that in Bulgaria any adjustment in terms of wages is made entirely at the expense of employment.

One of the obstacles to rapid economic growth comes from high corporate indebtedness. "A significant part of Bulgaria's external indebtedness stems from FDI (foreign direct investment), also in the form of foreign intercompany lending." Compared to the other EU countries, Bulgaria has a relatively large share of cross-border intercompany lending and a smaller share of banking sector foreign debt.

Private sector indebtedness is concentrated in the non-financial corporate sector - in 2010, corporate debt reached 124% of GDP which is very high level compared to other European countries. But the household debt level is moderate (28% of GDP) and the debt levels of the financial and public sector are low - respectively 9% of GDP and 17% of GDP. According to the Bulgarian National Bank, by the end of April 2012 gross, external debt amounts to 35 487.2 million euro, growing by 102.6 million euro (0.3%) compared to the end of 2011. As a percentage of GDP, Bulgaria’s gross external debt is 89.1 %.

However, the banking sector remains stable. Credit expansion until 2008 led to deterioration of the quality of the loan portfolio and non-performing loans reached 13.5% of total loans at the end of 2011. "Even though a deceleration of this trend is to be noticed since 2010, it is unclear yet whether the deterioration of the loan quality will proceed further or not", the analysis notes. It recalls that the capital adequacy of banks was increased to 18% in 2011 and the coverage ratio of non-performing loans by existing provisions was 69%, well above EU average. Bulgarian banks are not exposed to higher liquidity risk. So far there are no negative spillovers from the situation in Greece through subsidiaries of Greek banks operating in Bulgaria, which have no exposure to Greek private or public debt. The analysis notes that the government has reduced the fiscal reserves, thus limiting its ability to provide emergency liquidity support to banks in case of need.

Bulgaria`s external debt will continue to decline thanks to the balanced current account. The analysis even assumes that certain level of deficit can be considered sustainable, given the catch-up nature of the Bulgarian economy. Bulgaria should attract more capital, particularly in the form of FDI and import capital goods (machinery, equipment) to promote convergence, which could initially worsen the current account position but in the long term it will boost exports and GDP.

But when it comes to FDI, the analysis points out that it is not only about quantity but about quality as well. It notes that the low share of FDI in manufacturing in general and even lower share in higher value-added sectors is a cause of concern - food products, textile, metal products and chemicals account for 75% of FDI in manufacturing. That is why Bulgaria should seek to improve business environment and attract investment to support development of higher value-added sectors. It is also crucial to increase productivity, because the analysis warns of a potentially weaker growth period ahead, which will inevitably be reflected on the pay.

It is wages that are the criterion by which Bulgarians measure the benefits from their European membership and they have no reason for joy at this stage. But as the analysis clearly shows, if you want to catch up you need to run. And Bulgaria must run faster than everyone else because it starts from the last place. And also because it is not just about being a best performer in terms of fiscal indicators, it is about having a real improvement in the quality of life, allowing the country to move forward, instead of desperately struggling at least not to slip back.